Skipping Notice Period? There May Be GST Consequences
A recent ruling under the goods and services tax has come as a rude shock for employees leaving service without completing their full notice period.
An 18% GST will be applicable on the amount deducted or recovered by an employer from its employee in lieu of the notice period, the Authority for Advance Rulings has held.
A two member bench of the Gujarat AAR has ruled that an employer’s activity to accept the payment of a sum in lieu of any advance notice by the employee will be treated as a supply of service—a “declared service”—under the Central Goods and Services Tax Act, 2017.
Amneal Pharmaceuticals, a Gujarat based exporter, informed the authority that the company’s appointment letter stipulates employees can terminate their services by giving a prior notice of three months or making a payment in its lieu. It sought a ruling on the taxability of this amount.
To be sure, the GST law specifically says no tax applies on services provided by an employee to his employer in the course of employment. Yet, there have been certain rulings to the contrary. For example, the Rajasthan AAR ruled last year that consideration paid to directors by a company will attract GST in certain instances.
Recovery Of Notice Pay Can Be Treated As Consideration of Service, Says AAR
Amneal Pharmaceuticals argued against imposition of GST citing that:
Recovery of notice pay is a contractual arrangement to compensate the loss arising to an employer if an employee leaves without serving the notice period.
The law considers any activity as a taxable supply if a registered person agrees to refrain from an act or to tolerate any situation. But if the employee doesn’t work for full notice period, an employer can only recover the notice pay.
Therefore, the payment/recovery cannot be treated as a consideration for refraining or tolerating such an act.
And lastly, the obligations regarding the notice period emanate from the employment agreement and not any separate contract. Thus, it is an act in the course of employment and not otherwise.
It also cited rulings of various high courts where it was held that tax doesn’t apply on services provided by an employee to its employer.
Reading into the scheme of the CGST Act, the employment contract and various court rulings, the AAR held that recovery of notice period will be taxable because:
Notice pay by an employee can be regarded as a consideration to the employer for tolerating the act of non-fulfilment of notice period obligation.
Such act of tolerance is covered under the Schedule II of the CGST Act, which lists out services which will be treated as taxable.
Rulings cited by Amneal Pharmaceuticals pertained to the service tax era which won’t apply under the GST regime. And so, recovery of notice pay will attract GST at 18%.
Ruling Contrary To Established Legal Principles, Experts Say
Experts said the AAR ruling is contrary to established principles and may be challenged in courts. To be clear, the employer will be liable to pay GST on the amount that it recovers as a notice pay from the employee.
Nand Kishore, partner at DSK Legal, told BloombergQuint that the ruling is clearly contrary to decision of Madras High Court in the “GE T&D” case which clearly held that an employee suddenly leaving the employment would not amount to any act of toleration by the employer.
The authority has taken a diametrically opposite view and seems to have lost sight of the principles laid down by the high court which held no service was provided by the employer to the employee in such instances, he said.
This position will not change even in the GST regime. In the absence of a supply of service, there cannot be any levy of GST on the employer. The applicant should challenge the ruling before the appropriate appellate authority.Nand Kishore, Partner, DSK Legal
Rajat Mohan, senior partner at AMRG Associates, agreed.
Principally speaking, there should not be any tax on transactions between employer and employee, he said. The ruling would mean that there may be an additional burden on an employee as the employer may also recoup the additional GST from him. This is even if the employee can never be a service recipient in an employer-employee relationship, he said.
Commenting on the overall approach by the tax department, Mohan pointed out that authorities should refrain from using deeming fictions in the law to create illogical tax positions which are convenient to the department.